MCHP - Microchip Should Outperform The Semiconductor Industry In 2023

2023-03-14 11:12:15 ET

Summary

• Q4 revenue was up 23% y/y.
• Microchip has relatively little exposure to the PC and cellphone markets.
• The order backlog remains large.

Microchip Technology (MCHP) is known for specializing in microcontroller chips, but it has also branched out into adjacent spaces. 2022 was a very good year for Microchip, but of course what investors want to know is how it will do in 2023 and beyond. I will review the results from the December 2022 quarter. I will refer to them as Q4 2022 results, but accountants call them fiscal Q3 2023 results. When I refer to a year, in this article, I mean the calendar year, not the fiscal year. I will also look at how Microchip differs from the rest of the semiconductor industry and at its likely demand for 2023 and perhaps into 2024. Keep in mind that Microchip's stock price may depend on investor sentiment for the entire sector. That can be good, since we are looking for alpha, and in the longer run Microchip's stock price will depend on its own profitability, not that of the semiconductor sector.

Q4 2022 Microchip Results

Q4 2022 (fiscal Q3 2023) Microchip revenue was $2.17 billion. That was up 5% sequentially from Q3 2022, showing none of the slacking off some other semiconductor makers reported. It was also up 23% from $1.76 billion year-earlier. Resulting GAAP net income was $590 million, up 64% y/y as the higher volume and a strong pricing environment drove improved margins. GAAP EPS was $1.04, up 68% from $0.62 year-earlier. Non-GAAP net income was even better at $864 million, up 27% y/y. Non-GAAP EPS was $1.56.

The dividend was increased to $0.358, but that was already paid out on March 7, 2023. I do not consider Microchip primarily a dividend stock, but currently its yield is 1.76%. It is primarily a growth stock. The dividend, cash flow, and stock buybacks show its financial strength. In Q4 $230 million was used for stock repurchases while $410 million was used for dividends. Microchip did end the quarter with $6.59 million in debt against only $289 million in cash. The debt is from acquisitions and Microchip has been paying it down steadily. Microchip has also spent on expanding its production capacity in 2021 and 2022. Capital expenditures in Q4 2022 were $141 million, leaving free cash flow of $1.14 billion (about half of revenue!)

Microchip's specialization

The best-known of the semiconductor chip manufacturers, Intel ( INTC ) reported Q 2022 revenue that was down 32% y/y. What differentiates Microchip from Intel? Intel primarily produces high-end microprocessors for personal computers and server farms. Microchip microcontrollers have far-less -powerful processing units, but are hooked up to inputs and outputs that allow them to control a wide variety of external devices. Both companies manufacture networking chips and FPGAs, but Microchip's devices tend to be more specialized. In the quarter 56.3% of Microchip revenue came from microcontroller sales. 21.2% of revenue was from analog chips, which are generally engineered to compliment the microcontrollers. FPGAs, networking chips, and specialty memory chips account for the rest of sales.

Microchip's largest end market is Industrial, accounting for 40% of sales in 2022. Industrial includes a multitude of end uses for microcontrollers, from defense applications to complex manufacturing, scientific and electronic devices. Data center and computing sales accounted for 18% of revenue. The consumer appliance sector, including chips to control refrigerators and washing machines, accounted for 14%. The automotive sector brought in 17% of revenue and is likely to grow as the number of chips per car or truck manufactured continues to increase. Rounding out sales was the communications sector with 11% of revenue. The overall point is that Microchip has myriad customers within diverse economic sectors. A macroeconomic downturn can affect it, but a downturn in PC sales is not much of a factor.

Order backlog and future demand

In its February 2, 2023, press release and analyst conference Microchip guided to continued growth for the first quarter of 2023. Revenue is expected between $2.19 and $2.256 billion. After expenses that should result in a GAAP EPS of $1.07 to $1.09. Non-GAAP EPS should be $1.61 to $1.63. Capital expenditures are estimated between $154 million and $174 million as more semiconductor manufacturing equipment is purchased in order to try to keep up with demand.

Microchip entered the quarter with a serious backlog, meaning many customers were impatient to receive the chips they needed. Requests to cancel orders were minimal. In the quarter Microchip was able to catch up a bit on the backlog of orders. That was good for customers, with some seeing shorter lead times for their orders. With manufacturing capability expanding due to heavy investment, Microchip hopes to reduce the backlog and inventory during 2023. The target is to reduce order lead times to 26 weeks. At the end of 2022 Microchip was building its inventory (including its own raw materials) as part of its plan to decrease lead times.

Analysis

Even if the world goes into a recession in the second half of this year, it will likely take Microchip until about the end of the year to catch up with demand. The general trend, for decades now, has been for microcontroller demand to grow. Microchip has helped consolidate the microcontroller segment of the industry and is noted for its inventiveness, customer service, and financial efficiency. Microchip was one of my earliest investments and I have never regretted it. While black swans may arise anywhere, it is highly likely 2023 will be a good year for Microchip and the company will continue to grow revenue and profits for the foreseeable future.

Microchip is growing revenue fast, and profits faster. Yet it has a PE (forward price to earnings ratio) of just 13.6. Rapidly growing tech companies usually have much higher PEs. I think if results continue to be good there is no reason the stock can't reach the 52-week high of $87.76. That is a nice premium over the closing price on March 13, 2023 of $81.28.

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